Top Tabs

Tuesday, March 8, 2011

Trolling For Profits With Tessera

Patent trolls have a bad name in our society, but the principle behind their existence serves as the impetus for innovation. And to stay ahead of the competition, every successful company must put some emphasis on innovation. Some companies, such as Tessera Technologies (TSRA), put all of their emphasis on innovation.

Of Tessera's 480 employees, 329 are in R&D, which is rather extraordinary. They are busy looking for ways to in which to make things more efficient, particularly in the area of the miniaturization of electronic components and systems. The applications for such technologies are large; for example, consider how important miniaturization is for the fast-growing smartphone and tablet space.

But while the industries that Tessera caters to are growing swiftly, Tessera trades rather cheaply. The company's market cap is $885 million, despite a cash position of $475 million and earnings over the last four quarters of $57 million. Therefore, excluding the company's cash balance, it trades for a ttm P/E of just 7.

For value investors, however, this is by no means an automatic buy. While the company's industry growth prospects and earnings yield appear strong, the risks to this company are many. The company is of course competing against the in-house design teams of a whole slew of electronic component manufacturers. How well they earn in the future will be based on whether they can deliver superior technologies to the companies looking to bring products to market; unless you understand this industry well, this company is not likely to fall within your circle of competence.

Furthermore, as would be expected in this kind of company, intellectual property litigation is a risk. As per the company's recently released 10-K:

"[W]e are currently involved in litigation involving some...key patents in the U.S. The parties in these legal actions have challenged the validity, scope, enforceability and ownership of key patents that we license to generate a substantial portion of our revenues..."

And regarding one particular proceeding:

"A two-week hearing on the remaining issues is currently scheduled to begin on August 15, 2011...The Company cannot predict the outcome of this proceeding. An adverse decision in this proceeding could significantly harm the Company’s business and consolidated financial position, results of operations or cash flows."

Tessera has high growth rates and is cheap on an earnings basis. However, for value investors that's not enough. Investors must understand the sustainability of those earnings in order to proceed, and that requires an understanding of the business. For those with a circle of competence in which this company falls, Tessera may prove to be a strong company at a very cheap price.